From time to time I feel I must remind everyone – buyers, sellers, pundits, commentators, & analysts – that SaaS is not a pricing model or pricing strategy. From the vendor side, Software-as-a-Service (SaaS) is a unique Software Business Architecture where service is the focus over the technology. From the consumer side, SaaS is on-demand functionality that solves business problems, putting the focus more on the “service” aspect than the “software” SaaS might displace.

So, the notion that if you have a web-based, multi-tenant software product you must adhere to the same pricing tactics employed by every other vendor has come and gone. Just as SaaS vendors have created some amazingly sophisticated products that are a far cry from the simple web-based CRUD apps put out five years ago – not just because the technology has improved but the expectations of the market have matured and evolved as well – the pricing strategies employed by the vendors have evolved as well. And this is a great thing!

The impetus of this post came from an article on ZDNet by Larry Dignan the other day titled “SaaS pricing evolves: Should we be worried?” In that article Dignan discusses changes in SaaS pricing, especially around the “open secret” that some companies are signing multi-year contracts with SaaS vendors which prompts him to ask the question “Is this really SaaS pricing as initially conceived?“

As should be very obvious, SaaS itself has matured since the term was coined back in 2004 and now represents every functional area legacy software did. SaaS has moved beyond the small vertical, niche or departmental apps or less “mission critical” horizontal products – Salesforce.com, YouSendIt, Yammer for example. In 2010 you can run your entire business in the cloud with real SaaS products including wide-band horizontal products that a few years ago pundits questioned whether they were a fit for pure-play, multi-tenant SaaS.

These include such “not fit for SaaS” products as: Human Capital Management (HCM) from Workday and Enterprise Resource Planning (ERP) from Plex to Material Requirements Planning (MRP) from Rootstock or Supply Chain Management (SCM) from SPS Commerce. So as the complexity of what is available as SaaS and the requirements around the solutions (customization, on-boarding, training, etc.) evolve,it only makes sense that the pricing must evolve, too.

But it isn’t just the increased complexity of the products that has caused an evolution in SaaS pricing. SaaS vendors now realize that they are bringing value to a market specific to their product, and the problems it solves, and they need to be aligned with the customers in that market. This means they should not worry about what Salesforce.com is doing if they aren’t a CRM product and aren’t competing with SFDC.

Not all understand this yet – we work with clients to change their thinking on this every day – but savvy SaaS vendors are realizing that they are still competing with legacy software vendors, they might compete with other SaaS vendors, and even more important – they compete with the status quo – whatever that might be; an Excel spreadsheet, a clip board, or a home-grown software solution.

I think the crux of Dignan’s question is that the evolution of SaaS pricing has steered further and further away from “utility” pricing or this idea of only paying for what you use in the truest sense (paying in arrears, being billed by small usage metrics, etc.). The reality is that “utility pricing” has only seemingly come to fruition at the Infrastructure-as-a-Service (IaaS) portion of “cloud computing.” Amazon’s EC2 product in their Web Services line is a perfect analogy for utility-style computing.

With EC2, you spin up a compute instance (virtual machine), it does some work, and when it is done it spins down – like a toaster where the power company only charges you for the kWh used while making breakfast. Except that even Amazon has long-running charges for storing your VM image on S3, persisting data between sessions, etc. But you still only pay for what you use. Predictable recurring revenue that grows over time (increases CLV) is still the goal, even for “utility computing” companies like Amazon.

But sorry, SaaS is not utility computing – though because it is not a pricing strategy itself if that is aligned with your market, you could certainly price that way. It is critical to understand why SaaS is not a “utility.” This list is not complete, but just remember that a great deal of the value derived from SaaS happens outside of direct use of the product. Whether that is continuous improvement to the software itself, constant vigilance by the vendor to ensure business rules are up to date (tax laws, industry requirements, etc.), infrastructure upgrades, support systems, backups, etc.

These are elements that you as an end-customer would have had to support in the past. But now, you do not. Even more important are the Network Effects – the fact that a system becomes more valuable to everyone as more users join. From improving the user experience, to populating the system with actionable information not available to users of legacy software, SaaS is different and that is relevant to everyone, from the vendor to the end-customer.

So yes, SaaS Pricing has evolved – and will continue to evolve – and this is a great thing. It means SaaS is entering new markets with new value propositions and also indicates an increasing level of maturity among the vendors. For those who were only interested in SaaS because of the promise of “utility computing,” sorry to disappoint. But for those who understand the incredible value that SaaS can bring to the end-customer, the notion of better alignment in pricing to those customers means a greater adoption rate for SaaS and less barriers to acceptance by the customers.

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For SaaS & Web App companies, Subscription Revenue is a no-brainer, but doing it right is not!

There are many pitfalls Web App & SaaS companies need to look out for when it comes to pricing. If you keep the “Pricing is Marketing” mantra running through your head and “What’s In It For Them?” (them being your customers) as the framework for that marketing, you will avoid many of these mistakes,

As you read this, keep in mind this isn’t a “Top 5″ list; these aren’t in any particular order and the list is certainly not complete – 5 seems like a nice odd-number – but these are five things that SaaS & Web App companies (not just Startups) should look out for and try to avoid. What are others? Have you done any of these and had a good or bad experience? Please share your experience in the comments.

5. Don’t Under Value Your Offering

An issue I see very often is that SaaS & Web App companies completely undervalue their offering. This is not limited to startups, and certainly not limited to SaaS or Web Apps. But with a web app and the pedigree of being a “cheap” alternative to traditional or legacy software (which is misguided and wrong-headed thinking), this is pervasive.

This way of thinking simply boggles my mind since the vendor takes on all the infrastructure burden for the clients, updates the software powering the SaaS app on a daily – or more frequent – basis, reacts quickly to market changes, customer requests, etc. And yet, SaaS vendors in many cases put a low price on their offering. Why?

The reasons are many and varied but from what I see is a twofold problem. For starters, many SaaS and Web App companies are started by technologists. These technologists often feel “burnt” by legacy software and want to invoke change and completely undercut the “competition” – not understanding that they actually solve the problem better or more efficiently and could offer a *lower* price and undercut the legacy players but don’t need to do so in such dramatic fashion. In many cases, the opportunity is there to offer exponentially more value that they could actually charge more for; to have a low price-point on this makes no sense.

For many technical founders – and the thing that drives nontechnical people crazy – is that building the product is often relatively easy. The notion of “that’s just a CRUD app with some filters and a couple of calls to a third-party API” to a super talented developer might be the difference between a supplier to Walmart adhering to their latest mandate or losing a product line with their biggest customer. Get it? Easy for you (which is great) might have tremendous value to your customers.

Of course, the biggest reason for Under Valuing their offering comes from the SaaS vendor failing to clearly understand the use cases or the potential of the product. Who is the customer? Why should they care? What’s in it for them?

Or more precisely… what is the Value Perception of the customers? Here’s the hint, outside of IT/Infrastructure stuff, it is generally not the technology!

Just as with the other problems of under valuing, when a company’s executive team – or startup founders – are highly technical, they tend to focus on the “hard stuff” that they had to do, or that the application / service does and forget about the real value the customer would find in the product.

And of course, there are other problems with Undervaluing your Offering and they range from not charging enough to cover the cost of delivering the quality of service your customers expect/demand to coming in with such a low price that your market rejects you as a ‘toy’ for being too cheap. Yes, that happens.

The bottom line is that you need to get out of your own head and focus on “What’s in it for them?” – or what your customers get out of the service. This will change your game. If you under value and thus under price, you might have to raise prices later and unlike Mr. Ashworth’s experience above, it could end disastrously – so try to avoid undervaluing and get it as right as possible first.

4. Don’t Focus on a Specific Margin

When I see margin-driven pricing it is generally for one of two reasons. 1) Trying to match what was in your investor pitch or 2) to meet what you think is a “good margin” (based on the net margin of publicly traded SaaS companies, perhaps?).

If you consider “Pricing is Marketing” for even a second, you can understand that those two reasons as a driver of Pricing Strategy will lead to failure. Besides, backing into a price based on an investor pitch is a great way to make that entire pitch a wasted effort… investors aren’t as dumb as you think. That is good to remember, too.

Inside-out or Bottom-Up pricing, where you take what it costs you to land and support a client plus some type of margin, is irrelevant. If your costs are high (support, infrastructure, customer acquisition, etc.) your market doesn’t care. There is a price range they will support based on the current value proposition and if you can’t cover your costs within that price range, too bad.

You either need to figure out a way to lower your costs, figure out a way to get them to pay more, or accept that the market opportunity you thought was there, and your ability to capitalize on it, isn’t.

Of course, the best way to deal with this is to figure out a way to improve the value perception of the market (“What’s In It For Them?”) so that they will pay more for the product or service.

But wait… doesn’t pricing have something to do with finance? Something to do with accounting? Aren’t profit margins kind of important? Of course, but once you’ve covered your costs, everything above that is marketing. Remember that your price should be an input on a spreadsheet, not the output of a formula!

Here’s the reality… if you can’t cover your costs with the price that the market is willing to pay, and you can’t position your product or service so that the market will pay more, then you have not found a COMMERCIAL product / market fit.

The market doesn’t care what margin you want or what your cost of doing business is; they only know what they’ll pay for the perceived value that your product or service delivers.

Pricing is so much more than just some numbers in a spreadsheet or on a Pricing Page. Most of the time it’s more about the presentation and structure of the marketing around pricing than the pricing – the actual numbers – itself.

3. Don’t Just Guess

Ask 100 startups to answer honestly how they came up with their pricing and you are likely to find a statistically significant number that will say they just guessed. And not an educated guess, either.

For many SaaS and Web startups, thin-air is the second most popular place to pull pricing from. The problem with freshly minted startups is that they lack time in the market so they don’t understand customer behavior, buying patterns, etc.

Of course, time in the market is of little use, though, if there is not data to go along with it. SaaS & Web Apps that leverage an automated sales process have the ability to capture a great deal of the information associated with sales, churn, and usage unlike other businesses that require secondary systems to and processes to “capture” that data.

This doesn’t happen magically, though, so it is up to the company to ensure that they actually build-in the ability to capture that data – something to consider when architecting your SaaS & Web Apps, for sure.

But even when there isn’t time in market, and where there aren’t many competitors to look at, or when the competitors are not leveraging the same revenue model, you still shouldn’t guess!

When I help startups in this position with pricing, I use proxies or analogs (sometimes called benchmarks) which are companies that aren’t in the same market or don’t do the same thing but have a similar model. I apply a great deal of scientific as well as experience-driven processes to that data in an effort to try to get it as right as possible out of the gate.

But… none of this matters – analysis of historical sales data, proxies, etc. – if there is not a Pricing Strategy in place first.

It is critical that SaaS & Web App companies come up with a pricing strategy that is part of their marketing strategy if they want to develop pricing that is aligned with their goals and the market’s value perception.

Collect data, analyze it along with other market information, and make sure you have a Pricing Strategy in place and you’ll be much closer to getting it right out of the gate.

2. Absolutely Don’t Copy Others

For those that didn’t guess, under value, or focus on margins, copying another company’s pricing is the logical option, right? No!

Whether it is another company’s Pricing Page or the pricing itself, don’t copy. Ever.

Do the work required to ensure your pricing comes from a pricing strategy that is part of your overall marketing strategy. (Is there a theme here?). But I have seen companies, startups and later stage alike, that copy competitors pricing exactly.

I guess this makes more sense than copying companies that aren’t even in the same industry/vertical/niche, which I’ve also seen. For instance, an Oil Industry company providing a super-powerful vertical expertise & data product said to me recently “but what about how 37 Signals or Salesforce.com does it?”… craziness.

Look… you absolutely should know how the competition charges (what revenue metrics they use, billing cycles, etc.) and what their pricing is – but only so you know how you are different.If they are the market leader and have set the tone for years, and you come in with a different model because you have a deeper understanding of the market, you will need to know how to position that different pricing in the eyes of your market. Even if you know this is how the market really wants to pay, what they want to pay, etc.

But let’s look at the topic of “copying others pricing” from a different angle. Did you copy everything else your competitors do? Probably not. In fact, you are in business because you thought you could do it better, more innovative, more aligned with what the market wants, right? So why would you copy their pricing? Oh, because you think they got the pricing right?

That could be a seriously costly assumption!

1. Don’t Avoid Pricing Altogether

Finally, the other big mistake I see are companies who want to avoid pricing altogether. Whether this is by offering the product for free or using Ads, this happens. Of course you could do Freemium, but that isn’t a way to avoid pricing since the “premium” portion of the service requires a price, right?

Nope, I often see companies launching their product with absolutely no revenue model at first just to “get traction” to gauge interest. First, let’s be very clear… this is no indicator of “interest” in a paid service – only interest in a free product.

Next, without a very well-thought-out plan for how to move from Free to a paid service, this could seriously backfire – this includes more than just a Pricing Strategy, but a strategy for ensuring you don’t alienate the free user base.

Further, for companies that have a free service but use advertising as the primary revenue stream, here is an interesting insight – even ads have prices! Look at a company like Spiceworks, a B2B SaaS company that has around 1.5M users and who’s primary revenue stream is ads. They really only have ~250 customers – their advertisers – and you better believe they have a strong pricing strategy around those ads. You cannot avoid pricing unless you avoid doing business altogether.

Pricing is a critical piece of doing business – whatever the business. For SaaS & Web Apps that leverage an automated sales process, where the customer goes to the marketing website, to the pricing page, through the buying process, and then uses the product – without any human intervention – pricing is critical.

There is no sales person or consultant there to answer objections or read body language. No one to offer discounts rather than lose the sale. For this reason alone, it is critical to get your pricing – and marketing around your pricing – as right as possible out of the gate.

To do this requires work and avoiding the 5 mistakes above.

If you’ve been in-market at least 6 months and are curious how we could Accelerate your Profitable Growth – perhaps by optimizing your Pricing Strategy– contact me and we’ll setup a time to discuss your options for moving your company forward.